Arizona Supreme Court questions legality of education tax levied by Proposition 208

The Arizona Supreme Court cast doubt on April 20 on whether hundreds of millions of dollars in new taxes collected under a voter initiative enacted in November can be legally spent when a provision of the state constitution caps school spending.

Related: Arizona Supreme Court to hear challenge to new voter-approved education tax

The justices raised the questions during a hearing on an expedited constitutional challenge to the new voter-approved tax on high-earning Arizonans that was designed to boost school funding.

Lawyer: Proposition 208 "should have been a constitutional amendment"

"Proposition 208 is a statutory initiative that needed to be a constitutional amendment," said attorney Dominic Daye. "It’s an attempt to declare itself exempt from a portion of the constitution fails out of the gate when backers turned to the grant-gift exemption."

Opponents of the new tax focused on an exemption in Proposition 208 that gets around the school spending limit by calling the new revenue "grant" funding. Draye said that exemption just isn't legal.

"Millions of millions, hundreds of millions on education right now. That was the bargain presented to voters. So the two things the court knows objectively about severability is what the voters were told and how clearly it passed," said Draye. "So let’s say there’s $100 million that can be spent, there’s still $600 million that is not available to be spent, so we still have a right to controversy even if the court gets into this."

Justice Bill Montgomery focused on that argument when he questioned a lawyer for the Invest in Education Act, which is expected to raise more than $800 million a year in new taxes. He noted that about $600 million of that new cash might not be able to be spent if the court says the grant exemption isn't legal.

He noted that the Legislature had to seek a constitutional amendment to exempt a 2000 tax increase for education from the spending limit after the fact.

"I’m looking at the history that we have here and a previous effort to raise taxes for education and people realizing after the fact – oops – you can’t exempt a tax for education spending from the expenditure limit," Montgomery told attorney Andy Gaona.

Supporters say there are solutions

Gaona said there are multiple ways for the money to be spent, including the Legislature raising the spending limit, and urged justices to let the new law remain in force as voters intended.

"What it says is that additional funding is necessary," Gaona said of the new law. "And there is no question that Prop 208, even if the expenditure cap applies, will raise additional funding for schools."

Supporters also say the money not spent will sit in an account, and can be used another year.

Chief Justice Robert Brutinel questioned whether voters would have approved the measure if they knew much of the money could not be spent.

"Do you consider it rational to have a tax and spending scheme that puts hundreds of millions of dollars in an account and doesn’t provide a way to spend it?" Brutinel asked.

The court is being asked to declare Proposition 208 unconstitutional. They took the case under advisement and will issue a ruling later.

Supporters of Proposition 208, meanwhile, say the voters have spoken, and if the law is overturned, it will be very confusing.

"We’re looking forward to another decision in our favor, but what’s most important is that we get these critical resources into our schools," said Joe Thomas, President of the Arizona Education Association. " We can hire more counselors and nurses. We can have competitive salaries and wages for our classroom teachers and everybody that works for the schools. That’s what the voters told us they wanted."

Business group, GOP-controlled legislature brought lawsuit

The Republican-controlled Legislature and a group of businesses brought the challenge and also questioned whether the new tax required a two-thirds vote in November's election to pass, as tax increases imposed by the Legislature do.

"If Proposition 208 stands, Arizona will have one of the 10 highest individual income tax rates in the entire country," said Garrick Taylor, spokesman for the Arizona Chamber of Commerce. That’s important because it doesn’t only affect the so-called wealthy of Arizona, but also small businesses."

Proponents of the Invest in Education Act, passed as Proposition 208 with nearly 52% of the vote, say voter initiatives clearly do not require a two-thirds majority to pass. They say distributing the money through grants to schools is often used to avoid triggering the spending limit.

A trial court judge sided with the initiative's proponents when refusing to issue a preliminary injunction blocking the tax in February.

Related: Judge refuses to block Arizona’s new education tax

Law imposes tax surcharges for some

Proposition 208 imposes a 3.5% tax surcharge on income above $250,000 for individuals or above $500,000 for couples. Supporters say it could raise about $940 million a year for schools, although the Legislature’s budget analysts estimate it will bring in $827 million a year.

Related: Arizona approves Prop 207 recreational pot and Prop 208 schools tax hike

The measure was an outgrowth of a 2018 teacher strike that resulted in educators getting a 20% pay raise over three years. But the state did not meet their other demands.

Related: Arizona teachers marching in historic strike

Gov. Ducey, other state leaders looking at "fixes" for Proposition 208

Republican Gov. Doug Ducey opposed the measure and told a business group last month that he's hoping that either the state Supreme Court blocks the measure or the Legislature comes up with a way to sidestep the new tax.

Related: Arizona Gov. Ducey talks disdain for new education tax, vows fast fix

There are multiple tracks the Legislature could take, and one that eliminates about a third of the estimated $827 million a year in new revenue has already passed the Senate. That measure, by GOP Sen. J.D. Mesnard, creates a new tax code section just for small businesses, setting the top tax rate at 4.5% but avoiding the new 3.5% surcharge.

Related: Educators cry foul as Arizona lawmakers consider Prop 208 surcharge exemptions

Arizona small business income is currently taxed on personal tax returns. Opponents tried to persuade voters the new tax would hurt small businesses.

The Associated Press (AP) contributed to this report.

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